No clear winner found in target-date ‘to vs. through’ debate

For nearly two decades, the defined contribution industry has been embroiled in a vigorous debate over "to vs. through" and which of these target-date fund strategies can best help participants accumulate assets, reduce portfolio volatility and build a foundation for retirement.

The key issues are how much equity sponsors want for their participants — before and after retirement — and how much risk they can tolerate compounded by the fact that research shows there is no clear winner when it comes to long-term returns.

"There are arguments for both cases," said Leo Acheson, director of multiasset ratings for Morningstar Inc., Chicago. "It depends on factors such as risk tolerance, accumulated savings, the presence or absence of other sources of income in retirement, such as a pension. Either can be appropriate depending on investor circumstances."

Boiled down to basics, the "to" strategy starts with a high ratio of equity to fixed income in the years furthest away from a person's expected retirement date. The equity component shrinks over time until the series reaches the landing point — the vintage closest to a person's retirement. At the landing point, the ratio remains fixed permanently.

The "through" approach also starts with the high equity ratio, but at the landing point, the ratio continues to change past the retirement date. The glidepaths' slopes — the changing rate of the equity/fixed income ratio — differ between the two strategies and can differ within each approach.

Both strategies are typically marked in five-year vintage increments, such as a 2030 fund or 2035 fund.

"The 'to' strategy seeks to mitigate the risk of drawdowns near or at a desired retirement date," said Hamish Preston, associate director of U.S. equities for S&P Dow Jones Indices, New York. "The 'through' strategy seeks to mitigate longevity risk."

Although most target-date providers select one strategy, John Hancock offers both. "We give our retirement clients a choice," said Philip Fontana, head of investment product US at John Hancock Investment Management, which offers a "to" series and a pair of "through" series. "It depends on how much equity a client is willing to take." The company has $14 billion in target-date assets, evenly divided between the two strategies.

Although partisans maintain beliefs in their respective approaches, researchers and providers agree the explosive growth of target-date funds has made sponsors and consultants more attuned to many other issues to consider when choosing a target-date fund as well as "to" vs. "through."

"Cost, performance, the shape of the glidepath and underlying funds" are factors that sponsors review in choosing a target-date fund strategy, said Keith Holden, the Toronto-based head of retirement platform development and management, North America, for John Hancock Retirement.

"We are seeing an evolution of glidepaths with changes in the composition of equities and fixed income, as well as the use of non-traditional asset classes," he said. "That's an evolution I expect will continue."

Many early target-date funds took the "to" approach because providers and sponsors believed participants wanted conservative investments just before retirement and afterwards. "There was a lot of interest in a more conservative glidepath after the financial crisis" of 2008-2009, Mr. Fontana said.

His company launched a "to" target-date series in 2010, four years after offering the first "through" series. A second "through" series was added in 2013. The "to" approach "was created to de-risk substantially in the years leading up to retirement," Mr. Holden said. It gives employees a choice at retirement "to reallocate, rollover to an IRA or purchase an annuity."

However, for sponsors believing employees might need or want more equity in their target-date portfolio, the "through" approach "delivers higher equity exposure leading up to and following their assumed retirement date," Mr. Holden said.

Over time, the concept of the presumably conservative "to" approach and the presumably aggressive "through" strategy has become less precise. Consider this hypothetical example: Is a "to" strategy with a landing point of 30% equity more conservative than a "through" strategy whose landing point is 50% equity but whose equity component drops to 20% in 15 years?

At John Hancock, the "through" series has a landing point of 50% equity, and the equity component shrinks to 25% after 20 years. The "to" strategy initially had a landing point of 8% equity, though that figure can be adjusted by a few percentage points and it is now at 12% equity.

Over the years, the "through" strategy has outpaced the "to" strategy in popularity, although both have grown substantially. Assets for the "through" approach reached $1.045 trillion as of March 31, a sevenfold increase from year-end 2008, according to data from Morningstar Direct prepared for Pensions & Investments. Assets for "to" strategies were $118.2 billion as of March 31, up more than elevenfold since year-end 2008. Morningstar only covered mutual fund target-date series.

However, when assessing target-date returns, there is no clear winner between the strategies.

When S&P Dow Jones Indices issued its year-end 2019 target-date scorecard, it found that on average every vintage year for "through" target-date funds had higher returns than respective averages for "to" target-date fund vintages over three years annualized.

"Higher equity allocations helped to explain the higher returns" for the "through" group, the S&P report said. On average, across different vintages, "through" funds had a 10.9 percentage points higher equity allocation than "to" funds.

The "through" group, however, also was more volatile, leading S&P to conclude that on a risk-adjusted basis over three years annualized, the "to" group performed better.

"Higher equity allocations may help people to grow their nest egg and may help to avoid outliving assets," said Mr, Preston of S&P. "But equities have been more volatile than other asset classes, so higher equity allocations can result in higher volatility."

Some recent research by S&P prepared for P&I shows how short-term target-date performance can be influenced by major events.

Between Feb. 19 and April 24, the S&P Dow Jones target-date scorecard found that for every vintage (from 2015 to 2060 or higher), the "to" group bested the "through" group because the former's negative returns were less than those of the latter. Each vintage in each group posted a negative return during this period.

However, from Jan. 1 through Feb. 19 — the S&P 500 index peak — the reverse was true: every "through" vintage beat every "to" vintage. Each vintage in each group posted a positive return. The data was not risk-adjusted, and S&P didn't measure statistical significance for comparisons in this set of data or for its annual target-date scorecard.

Target date funds aren't short-term investments, so longer-term trends can look different, as illustrated in the data prepared for P&I by Morningstar Direct.

For the 12 months ended March 31, Morningstar Direct found that "through" retirement funds had an average return of -6.77% while "to" retirement funds had an average return of -8.47%. For the three-year period ended March 31, the "through" funds had an average annualized return of 2.05% vs. the average annualized return of 1.4% for the "to" funds.

Extending the measure to the five years ended March 31, Morningstar Direct said the average annualized return for the "through" funds was 2.87% vs. 2.37% for the "to" funds. The data isn't risk-adjusted, and a spokeswoman declined to say if the comparisons were statistically significant.

"Although 'through' managers on average have more equity exposure at retirement than 'to' managers, that's not always the case," said Mr. Acheson of Morningstar. "Plus, it's also important to understand the risk profile of a series' fixed-income sleeve" — an alert to sponsors that they should consider more than equity exposure when assessing a target-date series risk.

He cited an example of how some sponsors might support a "through" approach while others would prefer a "to" strategy due to differences in risk tolerances even though both use the same participant data.

For "through" advocates, sponsors may believe that "big savers" feel that they can afford more risk at retirement and thus take on greater equity exposure. For "to" sponsors, they might believe that big savers "want to protect their nest eggs" and don't want higher risk with more equity, especially those close to retirement, Mr. Acheson said.

Sponsors recently have been thinking about other target-date issues such as retirement income, "so that 'to vs. through' has taken a bit of a back seat," he said. "There are so many more variables today."

However, recent market volatility has brought the issue "back into focus," he said. As more sponsors encourage participants to keep their accounts in their plans after retirement, "and if sponsors rethink their target-date offering in light of recent market volatility, the issue of 'to' vs. 'through' could be more in play."